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Accounting Forum 34 (2010) 76–88

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Accounting Forum jour nal hom epage: www.elsevier .com /locate/accfor

Powerful players: How constituents captured the setting of IFRS 6, an accounting standard for the extractive industries Corinne L. Cortese a,∗ , Helen J. Irvine b , Mary A. Kaidonis a a b

School of Accounting and Finance, University of Wollongong, Northfields Avenue, Wollongong, NSW 2522, Australia School of Accountancy, Queensland University of Technology, Australia

a r t i c l e

i n f o

Keywords: International accounting standard setting Critical Discourse Analysis Extractive industries Regulatory capture IFRS

a b s t r a c t This paper illustrates the influence of powerful players in the setting of IFRS 6, a new International Financial Reporting Standard (IFRS) for the extractive industries. A critical investigative inquiry of the international accounting standard setting process, using Critical Discourse Analysis (CDA), reveals some of the key players, analyses the surrounding discourse and its implications, and assesses the outcomes. An analysis of small cross-section of comment letters submitted to the International Accounting Standards Committee (IASC) by one international accounting firm, one global mining corporation and one industry group reveal the hidden coalitions between powerful players. These coalitions indicate that the regulatory process of setting IFRS 6 has been captured by powerful extractive industries constituents so that it merely codifies existing industry practice. © 2008 Elsevier Ltd. All rights reserved.

1. Introduction The extractive industries are a powerful force in global political and economic relations. With this sector including oil, gas, and mining companies such as Exxon Mobil, BHP Billiton, Anglo American, and the Royal Dutch/Shell Group, the extractive industries are significant at both national and international levels. In 2005, the world’s top 20 extractive industries companies recorded profits in excess of US$ 211 trillion (Fortune Magazine, 2006). Comparing this to the United States’ 2005 Gross Domestic Product of US$ 11 trillion gives some idea of the enormity of this sector. When investigating an industry of this stature, it is appropriate to scrutinise the reporting practices adopted by entities to disclose financial information. As such, the accounting standards which guide the preparation of financial reports must also be considered. The most recent efforts to regulate extractive industry accounting were proposed by the International Accounting Standards Committee (IASC), now the International Accounting Standards Board (IASB).1 In 1998 when the IASC initiated the extractive industries project, its aim was to address the divergent accounting practices used by companies operating in the sector. By 2004 when the IASB finally released IFRS 6, Exploration for and Evaluation of Mineral Resources, the standard did little to regularise varied accounting practice and instead codified existing industry practice enabling companies to continue reporting in their preferred mode. To make sense what was essentially inaction by the IASB, the publically available discourse put forward during the process of setting the extractive industries standard was analysed using Critical Discourse Analysis (CDA). The outcome, IFRS 6, is

∗ Corresponding author. Tel.: +61 2 4221 3697; fax: +61 2 4221 4297. E-mail address: [email protected] (C.L. Cortese). 1 The IASC was restructured from the International Accounting Standards Board (IASB), which became operational in 2001. Throughout this paper both bodies will be referred to since the Extractive Industries project was initiated by the IASC and carried forward by the IASB. 0155-9982/$ – see front matter © 2008 Elsevier Ltd. All rights reserved. doi:10.1016/j.accfor.2008.11.003

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framed in terms of regulatory capture to suggest that the IASB was captured by the very constituents it was supposed to regulate. This paper presents some of that analysis, focussing on a cross-section of key players: Exxon Mobil, a major extractive industries company, PricewaterhouseCoopers (PwC), the audit firm for Exxon Mobil, and the American Petroleum Institute, a lobby group for the oil and gas industry of which Exxon Mobil is a member. The paper is organised as follows. The background details relating to extractive industries accounting and the methods of accounting for pre-production activities is first presented. This is followed by a description of the methodological approach based on regulatory capture theory and facilitated by CDA. Empirical analysis of publically available discourse provides evidence of the lobbying efforts of the key players, and conclusions are drawn on the basis of understanding the outcome of the international accounting standard setting process for the extractive industries as an example of regulatory capture. 2. Background Many companies engaged in the extractive industries are high profile, economically important, and have operations that span the globe. A diversity of approaches to accounting for and reporting the results of extractive operations has evolved in the world’s major mining regions of Australia, Canada, South Africa, the United Kingdom (UK), and the United States (US). As the extractive industries continued to become increasingly important globally, the IASC recognised that there was a need for an international accounting standard that would provide investors and other users with relevant, reliable, and comparable financial information (International Accounting Standards Committee, 2000a,b; International Accounting Standards Board, 2004a,b). In response to this perceived need, in 1998 the IASC added to its agenda an extractive industries project aimed at identifying and addressing the measurement and disclosure issues faced by the extractive industries. Among the many issues under consideration, a particular concern related to the methods used to account for pre-production costs by extractive industries entities. Pre-production costs are those incurred as a result of activities undertaken to explore the existence of mineral reserves and evaluate their commercial viability. These pre-production costs, also referred to as exploration and evaluation costs, can run into the hundreds of millions of dollars, and for some smaller exploration companies can be a substantial drain on resources in the search for oil or minerals. Over time, two main methods of accounting for pre-production costs have developed: the successful efforts method and the full cost method (Bryant, 2003; International Accounting Standards Committee, 2000a,b; Pratt, 1990).2 The important difference between these methods is the amount of pre-production cost capitalised under each method. Under successful efforts accounting, pre-production costs can only remain capitalised if they relate to the successful discovery and development of a mineral reserve (Flory & Grossman, 1978; International Accounting Standards Committee, 2000a,b). In the pre-production stage, all costs may be capitalised but if an exploration project proves to be unsuccessful, these costs must be written off. If the project is successful, then the capitalised costs are amortised against the revenue earned from the project (Amernic, 1979; Flory & Grossman, 1978; Frazier & Ingersoll, 1986; International Accounting Standards Committee, 2000a,b). The successful efforts method is arguably consistent with accounting principles of matching and conservatism, however the inherent uncertainty associated with exploration activities means that the income streams and asset balances of entities reporting under the successful efforts method can fluctuate significantly (Editorial, 1986; Frazier & Ingersoll, 1986). While this does not present much of a problem for large enterprises that can afford to absorb losses from unsuccessful ventures, it can be a significant issue for smaller companies and they have tended to avoid successful efforts accounting (Editorial, 1986; Frazier & Ingersoll, 1986). In contrast, the full cost method is much more popular with smaller exploration companies. Under full cost accounting, all pre-production costs regardless of whether they relate to a successful or unsuccessful project may be capitalised as an asset (Amernic, 1979; Flory & Grossman, 1978; Frazier & Ingersoll, 1986; International Accounting Standards Committee, 2000a,b). The pre-production costs are carried forward indefinitely and then matched against revenue derived from successful ventures. Because there is no requirement to expense unsuccessful projects under the full cost method, an income smoothing effect results (Flory & Grossman, 1978; Ingersoll, 1986; International Accounting Standards Committee, 2000a,b). For smaller companies with limited sources of finance, strict debt covenants, and aggressive exploration programs, the full cost method represents an opportunity to expand and develop (Amernic, 1979; Flory & Grossman, 1978; Frazier & Ingersoll, 1986; Ingersoll, 1986; Jeter, 2001; Johnson & Ramanan, 1988; Van Riper, 1994). The impact of each of these methods on reported profits can be substantial. For example, Premier Oil, an oil producer based in the United Kingdom, restated its profits in 2004 in preparation for the transition to IFRS (Neveling, 2005). Reporting under the full cost method, the company posted a $44 million profit. However, after switching to the successful efforts method, the result was a downward restatement of profits to $22 million (Neveling, 2005). It was this type of reporting disparity that prompted the IASC to address these reporting practices at an international level when it embarked on its extractive industries project in 1998 (International Accounting Standards Committee, 2000a,b; Micallef, 2001; Rabee, 2003; Wise & Spear, 2000). However, this is not the first time standard setters have sought to address the successful efforts versus full cost accounting issue.

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Variations of these two main methods have developed over time, however it is these two methods that are the focus of this research.

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The controversy over successful efforts versus full cost accounting first erupted in the 1970s and centred pre-dominantly in the US. In response to the 1973 world oil crisis, the US government enacted the Energy Policy and Conservation Act in 1975, which stipulated that standardised accounting practices for the extractive industries be established (Cortese, Irvine, & Kadonis, 2008; Katz, 1985). In 1997, the US Financial Accounting Standards Board (FASB) in charge of the standardisation proposed that the successful efforts method be mandated as the single method of accounting for oil and gas pre-production costs (Cortese et al., 2008; Flory & Grossman, 1978; Van Riper, 1994). In the deliberations that followed, proponents of the full cost method argued vigorously for the retention of both the full cost and successful methods, stressing the importance of the full cost method to the continuation and growth of US oil and gas exploration companies (Van Riper, 1994). The Ad Hoc Committee on Full Costing was formed by industry constituents, congressional leaders were targeted by companies and lobby groups, and many on the receiving end commented that they had “never seen such aggressive lobbying in their Washington careers” (Gorton, 1991, p. 30 cited in Van Riper, 1994, p. 64). The eventual outcome of all this was a win to the lobbyists. The FASB proposals were rejected by the Securities and Exchange Commission and instead a standard was issued that required extensive disclosures about oil and gas producing activities without actually mandating a particular method for disclosure (Katz, 1985; Van Riper, 1994).3 A multitude of investigations into accounting for the extractive industries emerged following the FASB’s proposal to eliminate the full cost method of accounting for pre-production activities and require entities to report under the successful efforts method. Numerous studies have examined, for example, the market effects of the proposed change in accounting method (Amernic, 1979; Baker, 1976; Collins & Dent, 1979; Dyckman, 1979; Dyckman & Smith, 1979; Lawrie, 1986). Other studies have investigated the relationship between accounting method choice (full cost or successful efforts) and company characteristics such as size, age, exploration aggressiveness, exploration success, demand for capital, and debt to equity ratio (Deakin, 1979; Lilien & Pastena, 1981). Other strands of research on the topic have attempted to predict reasons for switching between accounting methods (Johnson & Ramanan, 1988; Nichols, 1993), and have studied the relationship between successful efforts and full cost data and company share price (Al Jabr & Spear, 2004; Bandyopadhyay, 1994; Berry, Quirin, & O’Bryan, 2003; Bryant, 2003). Given that attempts to standardise accounting methods were unsuccessful in the US in the 1970s and that the IASB has also been unable to implement uniformity, there is a need to understand why this is the case rather than simply analysing the market effects of the different methods. To redress this imbalance in the literature, this paper applies a critical investigative lens to the international accounting standard setting process. It examines the due process of the IASC/IASB, the key players contributing to it, and evaluates the outcome, IFRS 6. It seeks to uncover the political connections and powerful coalitions that influence the process and shape its outcomes. Because this project is industry-specific, it provides a unique opportunity to study constituents that have common social, political, and economic interests. Critical Discourse Analysis provides a method to explore the standard setting process. Regulatory capture theory provides a lens through which to understand and interpret it. 3. Methodological approach: regulatory capture and CDA CDA positions the international accounting standard setting process in its social, political, and economic contexts and reveals the relationship between the IASC/IASB and extractive industries constituents. Central to CDA is the understanding that language (written or spoken) is integral to social life and fundamental to political negotiations at a number of levels. Fairclough (1993, 1995, 2003) identified three levels that must be considered in critical analyses of discourse: (e)ach discursive event has three dimensions or facets: it is a spoken or written language text, it is an instance of discourse practice involving the production and interpretation of text, and it is a piece of social practice (emphasis in original) (Fairclough, 1993, p. 136). Thus, each discursive event is comprised of three levels, while a simultaneous relationship exists between each level. It is the identification of linkages between these three levels that enables the relationship between “discourse, power, dominance and social inequality” (Van Dijk, 1993, p. 249) to be discerned and illuminated (Fairclough, 2003). By examining the text, or public discourse and the social structure within which the text is put forward (social practice), it is possible to expose the discourse practice as an “interactive process of meaning-making” (Fairclough, 2003, p. 10) that occurs as public discourse is produced, received, and interpreted. As part of the standard setting process, the Extractive Industries Issues Paper (hereafter the Issues Paper) was published in November 2000, and comments were invited from interested parties concerning the issues raised (International Accounting Standards Committee, 2000a,b). In response, comment letters were received from a variety of constituents including mining and petroleum companies, extractive industries lobby groups, and international accounting firms. At face value, these responses appeared fairly innocuous. However, by examining these responses and respondents through a critical investigative lens, in the vein of Sikka and colleagues (Mitchell & Sikka, 1993; Sikka, Willmott, & Lowe, 1989; Sikka, 1992; see for example Mitchell, Puxty, Sikka, & Willmott, 1994; Mitchell, Sikka, &Willmott, 1998, 2001; Sikka & Willmott, 1995), a number of overlapping interests among the respondents themselves, and between the respondents and the IASC/IASB, were revealed.

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For a more detailed discussion of the history of the successful efforts versus full cost controversy see (Cortese et al., 2008).

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It became evident that there was potential for powerful players to influence the international accounting standard setting process. CDA was used to examine these publicly available responses. CDA explicitly positions this discourse in the context of the social practices and institutional arrangements of the IASC/IASB. The international accounting standard setting process is viewed as an “interactive process of meaning making” (Fairclough, 2003, p. 10) through which discourse is used to exert “power, dominance, and social inequality” (Van Dijk, 1993, p. 249). In other words, CDA provides a framework through which to study documents, websites, and other archival data, and seek connections between these data. It facilitates understanding of a particular process or event rather than just looking for information for its own sake. By providing a framework that specifically searches for connecting relationships between key players in the standard setting process, the potential for regulatory capture to be exposed is far greater than if, for example, a content analysis-based method of reviewing comment letters was used. To facilitate an understanding of the standard setting process following analysis of discourse, regulatory capture theory is adopted as a theoretical lens. Regulatory capture explains the predisposition of regulated industries, such as the extractive industries, to capture the regulatory body, in this case the IASC/IASB (Mitnick, 1980; Walker, 1987). Regulatory capture theory was derived from economic theories of regulation, which sought to explain the pattern of regulation by governments (Posner, 1974). Developed by “an odd mixture of welfare state liberals, muckrakers, Marxists, and free market economists”, regulatory capture theory was used to argue that regulation was supplied in response to the demands of particular interest groups (Posner, 1974, p. 335). Mitnick’s (1980) conception of regulatory capture focused specifically on the relationship between regulatory bodies and the industries they were intended to regulate. It considered how aspects of this relationship can promote capture and result in the regulatory body making decisions and taking actions consistent with the preferences of the regulated industry (Mitnick, 1980). Very few accounting studies have examined accounting regulation from this perspective. A notable exception is a study by Walker (1987), a former member of the Accounting Standards Review Board (ARSB) in Australia, who provided a personal account of the Australian accounting standard setting process.4 Walker (1987) used Mitnick’s (1980) theory of regulatory capture to argue that the accounting standard setting process in Australia had been captured by the interest groups it was established to regulate. In developing his argument, Walker (1987) traced the early history of the ASRB and noted the lobbying power of the accountancy bodies in the early stages of the ASRB’s formation, which ensured that the ASRB would not have independent research capabilities. He also argued that the profession had “managed to influence the procedures, priorities, and output of the Board”, and further, that it had influenced appointments to the Board so that “virtually all members of the Board might reasonably be expected to have some community of interests with the profession” (Walker, 1987, p. 282). Having provided a convincing argument for the regulatory capture of the ASRB, Walker (1987) concluded by stressing the impor...